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Saturday, February 27, 2010

The Islamic legal maxim “al-ghorm bil ghonm” that is, “no reward without risk” is an important principle in Islamic finance. Discuss why this is so?

The explicit Quranic verse (Al-Baqarah : 275) says that “Allah hath permitted trade and forbidden riba (usury)....”, to counter back the claims made by the Meccan pagans that the trade (al-bay) is like usury. For them, the excess return over the loans provided to debtors are exactly the profits gained from the trade. However, when one looks closely to the nature and function of riba, it is, in fact, an extremely oppressive business activity.

First, in riba-based loan, the principal amount is guaranteed to be returned by the borrower. Secondly, the borrower undertakes as a condition of the contract to pay extra to the lender. Now, in the case the borrower using the money for business and resulted in loss, he still has to pay principal plus interests to the lender. Likewise, there will be serious legal implications when the loan defaulted. If the loans are collateralised, the lender may wish to sell the assets to recover his money. Thus, in interest contract, it only favours the lending party who will receive profits without taking any risk. Such profit-making technique is considered an unfair business practice because profits are created without mutual risk-taking between borrowers and lenders and disrupts the spirit of cooperation.

In Islamic jurisprudence, the legal maxim al-ghorm bil ghonm” or “no reward without risk” holds the truth. This means that one cannot expect to make profit without associating it with risk in his undertakings. The principle is constructed based on the Quranic verse and Hadith (prophet says, actions and silences). This is the Islamic economic principle on risk-return relationship principle and implies that the al-bay’ (the trade) is favoured by Allah rather than riba. The rationale legitimisation of al-bay’ (the trade) is not only to the impact on the social order, but to the economic activities and economic realities itself. By participating in risk-sharing between borrower and lender for the profit motive, it enhance cooperation (ta’wun) sense and thus, it establish the social order that promoted by Islam.

In economic activities and realities sense, the trade itself is not free from risks. The business may be generating profits or loss depending on the market reaction. On top of that, force majeure (natural disasters) might happen which will result the entrepreneurs loss the businesses. However, this is a legitimate way to make money as prescribed by Islam. In interest contract, profit from loans (i.e. riba or usury) is created without risk-taking from the lenders. This is definitely unjust. Islam wants the relationship between the parties involved to be based on justice. Return on a deposit and, simultaneously, protection of the deposit from the risk of loss do not go together in Islamic banking environment. Investment and special investment accounts are Islamic bank’s counter parts of conventional system’s fixed deposit accounts based on mudarabah (capital participation) concept. Under the arrangement, the bank will use the deposits for investment purposes. The profit will be shared between the bank and the customers. At the same time, the investment account holders bear part of the losses if the project fails. The bank will lose its efforts and labours. This sort of profits is encouraged by Islam because the justice does materialise from the principle of “no reward without risk”.

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